A Bubble Doesn't Have to Be Dangerous

 | Nov 14, 2013 | 3:28 PM EST  | Comments
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Is there a bubble in the stock market? And if there is one, is it so inflated that it will lead to a crash as surely as the Hindenburg in Lakehurst, N.J. in 1937?

These are the questions that must be answered if people are going to make informed decisions about a stock market at historic highs that doesn't seem to ever want to quit.

First, let's address the overall market bubble question, something that's Topic A because chief bubble blower Ben Bernanke is giving way to Bubble-in-Chiefer Janet Yellin. There is no doubt that the Federal Reserve's policies have greatly and positively influenced the stock market. By keeping interest rates low, thereby eliminating the bond market competition, you put a floor on stocks with good dividends that give you outsized yields vs. the miserable 0.8% 5-year CD. The Fed has created the bond market equivalent of stocks and that's been a huge positive for the market.

The Fed's also created such cheap capital that companies can afford to buy back stock, which can radically inflate earnings per share and in some cases put floors under stocks.

The Fed's easy policies allow more cars to be sold and more homes to be bought. Consumers with decent credit can get cheap financing. That leads to more cars being built, which requires more workers to be hired. As you can see today with the huge rally in housing, because Yellen said she embraces the policies of Ben Bernanke, the homebuilders can put more people to work and Home Depot (HD), Weyerhauser (WY), Whirlpool (WHR) and Sherwin-Williams (SHW) can also do much better. As I always say, housing punches above its weight and the collateral positives of the Fed's largesse ripple throughout the stock market.

But isn't that the real point here? It's not collateral damage. These are collateral positives, matters that aid the wealth effect, which allows more spending, which helps retail. These are matters that allow more people to be hired because of the need to expand. These are matters that get the economy moving again.

I point these out because the government, away from Yellen and Bernanke, through the fault of partisanship, is on the polar opposite course. It's cutting back spending, reducing stimulus and hurting the economy at every turn. The only area that it is putting money into is healthcare and that Medicare money doesn't have the multiplier effect that the Fed's stimulus has.

Which leads me back to the bubble concept. A bubble is something that, per se, isn't dangerous IF you know the bubble's not going away any time soon and we got a lot of certainty from Yellen today that it isn't. Because it isn't, it pays to stay more long or own more stock than if you didn't. Plus, the bubble won't be deflated until the economy gets stronger and if the economy gets stronger, then earnings should move up accordingly. It's not like the bubble will be burst because companies will be doing worse. It will be because companies are doing better. So you have this situation where the bubble gets taken away by something else that is good for the stock market, not bad for it.

Now, I think there are plenty of people who think "this is wrong." They think that the fact that something is collaterally positive is no different from something being collaterally negative. It's just bad in and of itself.

I don't make those judgments. They get in the way of making money, which we never should forget is what we are supposed to be doing. Passing judgment on this process and the Fed is a parlor game to me, no different from trying to figure out who is going to win this weekend in football. But we are trying to make money and I will not let that parlor game get in the way of my thinking.

Ah hah, though, how about if it all leads to inflation, won't that be terrible? Yes, I hate inflation as much as the other guy, but it's deflation that the Fed is fighting, the deflation that comes from a tight Congress and from free trade, which allows our companies to pay less and less for workers. Anyway, there's plenty of slack in the system and do you mind if we wait until we at least get a couple of months of data showing inflation before we wore about something that's not happening?

Oh, and let's not forget the money management imperative. Even if you think that I am wrong about inflation, even if you think that what the Fed is doing ends badly and that we are ultimately going to be in a heap of trouble from the collateral positives, let me remind you that the bogey of performance, the need to catch up to the averages, is forcing money into this market not out of it and the supply of stock isn't growing, it is dwindling, as winning managers aren't about to ring the register. They are letting it ride, And remember the performance gains you get now are as legitimate as ones gained during the beginning of the year from the fundamentals. So don't sneer at them.

Now, let's deal with what's happening in the Internet space. Is Twitter's (TWTR) valuation a bubble? Does paying $3 billion to a 23-year-old who invented Snapchat signify a bubble? Do Yelp (YELP) and LinkedIn's (LNKD) valuations signify bubble?

Yes. Of that there is no doubt. But I don't know what to do about it other than to tell you that it's a bubble. I can't get you to not overpay. I am not going to go outside my traditional metrics to foment reasons why these stocks are cheap in the uniques per share or eyeballs per share or tweets per share or any other knuckleheaded rationalization, justification or alibi.

But I will tell you that the reason all of these companies can trade where they do is Amazon.com (AMZN). You see, Amazon is the bubble umbrella. It is what allows people to pay these prices for these stocks. It is what allows for the inflation of equities that do not have profits and may not have profits for years. Amazon, which hit a high today, is a $168 billion company that doesn't show a profit. So how do we know if Yelp or Twitter or Facebook (FB) aren't the next Amazons. Isn't it worth it to bet that it might be? I can see why you would. In fact, let me go a step further. A lot of people think that if you are buying Twitter, you are buying into the greater fool theory that someone even more stupid than you are is going to buy the stock higher and make you money. Yet, let's say someone took you out of Amazon at $80 after you bought it at $70. Now with Amazon at $367, who is the greater fool? I think you are.

I believe it is entirely possible to have a side-by-side situation where the bubble of the Internet can occur at the same time that the overall market goes higher. And remember, I do not believe the overall market is in a bubble. I think it is reasonably priced vs. other assets. Relative valuation, not absolute valuation, for better or for worse, is the method I use to identify bargains and exploit them.

So, in the end, I am not giving up on the overall market, at least not here, not now. Maybe later. Maybe higher. But not yet even, as I never frown on anyone taking a profit. One day if they make it illegal to be along for the ride, even if I don't like the ride, then I will get off. But right it looks real legal to me and also real smart and lucrative.

That's what matters.

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